This is the second in a planned series of posts assessing the implications of the global financial crisis for the economic ideas and policies that have been dominant for the past few decades. The large-scale privatisation of publicly-owned enterprises both in capitalist countries like the UK and Australia and in formerly communist countries after 1989 played a big role in promoting the kind of triumphalism that characterised much commentary about free-market capitalism in the 1990s and (to a somewhat lesser extent) in the years leading up to the crisis. How well do arguments for privatisation stand up in the light of the financial crisis.

The case for privatisation had two main elements. First, there was the fiscal argument for privatisation, namely, that governments could improve their financial position by selling government business enterprises. This argument assumed that privately owned firms would have higher levels of operating efficiency, and therefore that the value of those firms would be increased by privatisation. The second argument was a dynamic one, that the allocation of capital between alternative investments would be improved if governments were not involved in the process. Both of these arguments have been fatally undermined by the collapse of the efficient markets hypothesis.

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Microsoft Zune music players stopped working on New Years Day because of a software bug, raising the inevitable comparisons with the Y2K fiasco. The way in which the largely spurious Y2K problem was handled raises some interesting comparisons with the all too real problem of climate change. Although many billions of dollars were spent on making systems Y2K-compliant, there was no serious scientific study of the problem and its implications. The big decisions were made on the basis of anecdotal evidence, and reports from consultants with an obvious axe to grind. Even the simplest objections were never answered (for example, many organisations started their fiscal 2000 year in April or July 1999, well before remediation was completed, and none had any serious problems). There was nothing remotely resembling the Intergovernmental Panel on Climate Change, let alone the vast scientific literature that needs to be summarised and synthesised for an understanding of climate change.

Thus, anyone who took a genuinely sceptical attitude to the evidence could safely predict that 1 January 2000 would pass without any more serious incidents than usual, even for the many countries and businesses that had ignored the problem. The retrospective evaluations of the policy were even more embarrassingly skimpy. I analysed some of the factors involved in this paper in the Australian Journal of Public Administration.

A really interesting point here is the fact that, in the leadup to 1 January 2000, self-described global warming sceptics, for the most part, went along with the crowd. If any of them rallied to the support of those of us who called for a “fix on failure” approach, I didn’t notice it. By contrast, the moment that the millennium had arrived without incident, retrospective scepticism about Y2K became a staple of their rhetoric. The IPA, for example, started its commentary on 15 January 2000 and it’s been a staple ever since. Of course, I’m open to correction here. I’d be very interested if anyone could point to a piece published before 2000 taking a sceptical line both Y2K and AGW.

I’m starting my long-promised series of posts on economic doctrines and policy proposals that have been refuted or rendered obsolete by the financial crisis. There will be a bit of repetition of material I’ve already posted and I’ll probably edit the posts in response to points raised in discussion.

Number One on the list is a topic I’ve covered plenty of times before (in fact, I was writing about it fifteen years ago

), the efficient (financial) markets hypothesis. It’s going first because it is really the central microeconomic issue in a wide range of policy debates that will (I hope) be covered later in this series. Broadly speaking, the efficient markets hypothesis says that the prices generated by financial markets represent the best possible estimate of the values of the underlying assets.

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There’s been a lot of talk about the idea that the GFC (the in-group shorthand for ‘global financial crisis’) is an example of a ‘black swan’, that is, an event that would be treated as impossible on the basis of induction from past experience, and hence that could not be encompassed by formal models of the kind used by risk managers. All this talk has of course been great for Nicholas Taleb who has a book with this title. It’s good in a lot of ways, but I found it ultimately insufferable in the continuous repetition of the message that only Taleb was smart enough to see all this. ( To be fair, Taleb predicted a global financial crisis, and didn’t simply claim it in retrospect as an unpredictable Black Swan).

I spend a lot of my time working on how to think about unforeseen contingencies and I’m not at all convinced that the GFC should be described in this way. Of course, the models used by the risk managers in investment banks didn’t include this as a possibility; if they had, the implication would have been that all sorts of much-desired deals should not go ahead. But as I pointed out a while ago, very simple models based on well-established principles predicted that the bubble economy would end badly.

The crisis then, involved something more like dark matter, the ‘missing’ matter in the universe that must exist if it is to work as it does, but can’t at presented be detected. Given that risk can’t easily be made to disappear*, it was obvious that the risk associated with lending of all kinds (most obviously, mortages offered to people with no capacity to repay) was being borne by someone, and probably someone who was unaware of it.

The big problem for the Cassandras (and we were certainly both correct and disregarded) was that it was easy to see that the bubble could not continue and much harder to foresee how it would end – it’s one thing to say that dark matter must exist and another to work out what it is really like. Like Brad and Brad, I expected that the problems would emerge first in the form of a run on the US dollar, given that holders of US dollar assets were receiving very little compensation for the obvious risk of large capital losses. In fact, the US dollar actually rose in the early stages of the meltdown, though it has been falling more recently.

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That’s the new target interest rate announced by the US Federal Reserve today (with a margin of up to 25 basis points). It’s also, following the $50 billion Madoff fraud and the increasingly widespread suspicion that the entire bailout scheme has been operated to promote the interests of Goldman Sachs at the expense of its competitors and the general public, an upper bound for the credibility of the global financial system. And it’s a pretty good estimate of the probability that we’re going to avoid a recession worse than any since the Great Depression.

Without a household name like Citigroup or GS going bust, it’s hard to convey the seriousness of the latest news in an environment where we are already inured to financial cataclysms. But it seems pretty clear that the last couple of days spell the end for both hedge funds (many of which have lost a fortune with Madoff and all of which are subject to invidious comparisons with his decades-long Ponzi scheme) and money market funds, which can’t possibly cover their costs while paying positive net returns, given a funds rate of 0.25 per cent.

Finish Line movie download

I’ve been meaning for a while to post some links to sites promoting campaigns to protect the rights of workers including the right to organise unions. Here are a few
Justice4Luke a site about the case of a union organiser sacked by the charity for which he worked.
LabourStart, an international site supporting union rights in many countries
Evatt FoundationAn Australian site with lots of useful analysis. One of the early Oz political bloggers, Chris Sheil, writes a fair bit there.

I’ve spent the last couple of days at a workshop sponsored by the Academy of the Social Sciences in Australia on shifting allocations of risk. Most of the papers were well underway when the collapse of global financial markets implied the need for a radical revision of thinking. So a lot of discussion was prefaced with “at least until the onset of the crisis, this trend was ….” Here’s my paper.

Sad news from Calculated Risk. Doris Dungey, who blogged as ‘Tanta’, has died of cancer. She was an insightful commentator on a lot of issues, but particularly those related to the crisis in real estate and mortgage markets.